Question

St. Johns River Shipyards' welding machine is 15 years old, fully depreciated, and has no salvage value. However, even though it is old, it is still functional as originally designed and can be used for quite a while longer. The new welder will cost $184,500 and have an estimated life of 8 years with no salvage value. The new welder will be much more efficient, however, and this enhanced efficiency will increase earnings before depreciation from $29,000 to $83,000 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 40%, and the project cost of capital is 15%. Should the old welder be replaced by the new one? Do not round intermediate calculations. Round your answer to the nearest cent. Negative value, if any, should be indicated by a minus sign.

The NPV of the project is $

Old welder (select: should or should not) be replaced.

Answer 1

Given in the problem new asset is 100% depreciated and MACRS as 5 years but if we add 5 years depreciation  rates it is not equal to 100% so assumed as MACRS as 6 years

Also the old machine is 100% depreciated so now depreciation is only pertaining to new welder

given new welder cost= 184500

New welder will generate additional earnings before depreciation of $( 83000-29000)=54000$ per year

Step1 calcualtion of depreciation

year	Depreciation rate	Depreciation amount
1	20%	36900= 184500*20%
2	32%	59040= 184500*32%
3	19.20%	35424= 184500*19.20%
4	11.52%	21254.4= 184500*11.52%
5	11.52%	21254.4= 184500*11.52%
6	5.76%	10627.2= 184500*5.76%

Step 2 calcualtion of additional cash flows due to invest in new welder

year	Increased earnings before depreciation (A)	Depreciaton B	Earning after depreciation (A-B)=c	Tax E= (D*40%)	Net increased earnings before depreciation (A-E)/ incremental Cash flows per year
1	54,000	36900	17,100	6840	47,160
2	54,000	59040	-5,040		54,000
3	54,000	35424	18,576	7430.4	46,570
4	54,000	21254.4	32,746	13098.24	40,902
5	54,000	21254.4	32,746	13098.24	40,902
6	54,000	10627.2	43,373	17349.12	36,651
7	54,000	0	54,000	21600	32,400
8	54,000	0	54,000	21600	32,400

Step 3 calcuation of Net present value of the new welder investment

year	Cash flows from step 2 (A)	Present value at 15% (B)	Discounted cash flows(A*B)
0	-184,500	1=1/(1.15)^0	-184500
1	47160	0.869565=1/(1.15)^1	41009
2	54000	0.756144=1/(1.15)^2	40832
3	46569.6	0.657516=1/(1.15)^3	30620
4	40901.76	0.571753=1/(1.15)^4	23386
5	40901.76	0.497177=1/(1.15)^5	20335
6	36650.88	0.432328=1/(1.15)^6	15845
7	32400	0.375937=1/(1.15)^7	12180
8	32400	0.326902=1/(1.15)^8	10592
		total	10299$

Since the project is having worth more than the cost of investment it is better to buy the new welder

NPV of the new welder is 10299$

The old welder should be replaced